Interest Rate Hedging Products Mis-selling
On Friday 29 June 2012, the FSA published its initial report on the mis-selling of Interest Rate Hedging Products ("IRHP") to SME businesses, following a two month investigation.
Since then, a further 7 banks have "volunteered" to review their sales of IRHPs to SME businesses.
This is the latest (and potentially the most expensive) in a series of high-profile financial products mis-selling issues that have impacted UK banks' balance sheets in recent times. We summarise the FSA's key findings below and provide an update of the current status of the compensation scheme proposed by the FSA.
The FSA's investigation covered sales of IRHPs from 2001 to date and has established that about 28,000 IRHPs were sold to customers during that period. No reliable projections of the possible levels of compensation have been published, but current estimates range from between £1 billion to £2 billion.
The FSA's findings were that there have been "serious failings" on the part of the big four retail banks, including the inappropriate sale of the more sophisticated IRHPs and bad sales practices. These practices include:
- inadequate explanation of the downside risks and exit costs involved in IRHPs
- failure to explain the speculative risk nature of, in particular, structured interest rate collars;
- failure to ascertain customers' risk profile;
- over hedging; i.e. selling IRHPs which did not match the term or value of the loan.
The FSA was careful to acknowledge the value of hedging and IRHPs as financial management tools; indeed its Chairman, Adair Turner, was recently quoted by Reuters as emphasising their value: "correctly sold, and in many cases they were correctly sold, these can be good products". However, the FSA's findings were that in the case of "non-sophisticated customers" – meaning businesses with a turnover of less than £6.5 million or a net balance sheet value of less than £3.26 million or employing less than 50 employees, such customers "are likely" to lack the expertise and understanding of IRHPs, which made them inappropriate for sale to such customers.
The FSA's report of 29 June 2012 states that it has reached agreement with the big four retail banks, Barclays, HSBC, Lloyds and RBS, by which the banks will provide compensation to customers who purchased IRHPs, and will undertake a full post sale review of sales of IRHPs after December 2001.
The compensation scheme and sales review only relate to "non-sophisticated customers" – sophisticated customers' claims or complaints will be dealt with by the banks' standard complaints procedures.
For non-sophisticated customers, the agreement reached was that the banks will:
- provide compensation to purchasers of "structured interest rate collars";
- review other IRHPs;
- review the sale of "cap" IRHPs if a non-sophisticated customer complains in relation to that product during the course of the review.
The review will be supervised by an independent appointed reviewer and overseen by the FSA.
The key points about the compensation scheme are: (1) that the compensation will be determined by reference to the standard of "what is fair and reasonable"; (2) compensation can also include cancelling or replacing current IRHPs with alternative products, or refunding the cost of the IRHPs; and, (3) compensation appears to be mandatory in the case of customers who bought structured interest rate collars.
Finally, the FSA draws attention to the option open to customers, such as private individuals and 'micro-enterprises' (i.e. a business with a turnover or net balance sheet value not exceeding €2 million and employing less than 10 people), to refer their complaint to the FOS. The FOS may have limited involvement given the FOS compensation limit of £150,000; however, the FSA report refers to having written to the FOS asking them to consider constructing a specific scheme dealing with the outcome of the review. This may again test the meaning and boundaries of the FOS' £150,000 compensation limit.
On 23 July 2012, the FSA published a press release announcing that Allied Irish Bank (UK), Bank of Ireland, Clydesdale Bank, Yorkshire Bank, Co-operative Bank, Northern Bank and Santander UK have "volunteered" to review their sales of interest rate hedging products to small and medium-sized businesses.
The FSA has not examined the sales of IRHPs by these seven banks and has not made any adverse findings of misspelling against them; however, these seven banks will take part in the review of the sales of these products and the redress exercise on the same basis as the four larger banks that signed the settlement agreement in June 2012
On 3 September 2012, the FSA updated its interest rate hedging products webpage to report on progress made on the redress exercise. The update includes the following information:
- A number of the banks have appointed their independent reviewers, which the FSA has approved. The FSA is now reviewing the nominations from the remaining banks.
- The FSA is requiring all the banks to propose a methodology setting out how they propose to conduct the redress scheme. Each bank will conduct a pilot exercise with a sample of customers to assess each bank's approach. The FSA will use this exercise to review the banks' proposals and will propose changes, where necessary.
- The banks will not be able to press ahead with the redress scheme until the FSA is satisfied with their methodology. This may mean that the exercise will take longer than originally anticipated.
- The FSA has stated that it expects the banks to focus on getting redress to customers as quickly as possible.
We are keeping a very close eye on the IRHP mis-selling issue and will update this blog with any material developments over the coming weeks/months.